August 23, 2014
Should a new organisation committed to social good choose a for-profit model or a nonprofit one? This is a question we face each year at my organisation, Echoing Green, when we evaluate thousands of business plans from social entrepreneurs seeking start-up capital and support. This year, nearly 50 per cent of those plans proposed using a for-profit model. And when we asked these entrepreneurs why, some of their reasons were just plain bad.
Related: As part of The Crunch program, run by Social Traders, participants create or improve their business plan, including evaluation of legal structure options.
New entrepreneurs are increasingly starting for-profit firms whose primary purpose is to make a social impact. Supporting this trend is a tremendous increase in capital available for “impact investing”. According to a recent report from JPMorgan Chase and the Global Impact Investing Network, impact investors contributed nearly $11 billion across 4900 deals in 2013, up 250 per cent from 2011.
Going with a for-profit model can be a good choice for the right organisation, but too many entrepreneurs are doing so for the wrong reasons. Here are some of the worst:
Only for-profits use “business discipline”. It’s easy to scan headlines and find undisciplined for-profit companies like General Motors and American Apparel. If “business discipline” means a thoughtful, hard-nosed, numbers-driven approach to delivering results, organisations such as Teach for America (with a $250 million annual operating budget), the multibillion-dollar global development agency BRAC, or even well-known institutions like Harvard University and the Cleveland Clinic are great examples of disciplined nonprofits. Clearly, for-profits don’t have a monopoly on discipline.
Only for-profits can sell products and services. This is a misunderstanding of corporate law in most countries. Whether your organisation is for-profit or nonprofit doesn’t typically affect your ability to sell products. There are some nuances in China and India, but in most parts of the world, and certainly in the United States, nonprofits can sell products and for-profits can accept donations. In the 2013 class of Echoing Green fellows, five of the 12 nonprofits earned revenue, and five of the seven for-profit companies received donations.
Only for-profits properly compensate employees. Many nonprofit social entrepreneurs earn a good living. And in sectors such as education and health care, nonprofit compensation is often at the same level as that of for-profits. But it is true that when nonprofit leaders earn salaries close to their for-profit peers they are scrutinised. And it is certainly true that because nonprofits don’t maintain shared ownership structures, a Facebook founder’s payday isn’t in their future. Commitment to social entrepreneurship may mean lower lifetime earnings. So talk of “proper compensation” may be a signal that a particular entrepreneur is not a good fit for our model, which demands deep commitment to the social purpose.
Only for-profits have a sustainable revenue model. There are usually two intertwined misconceptions here. First, there’s the earned income fallacy. Despite notions to the contrary, if an earned income model is most sustainable for a particular company, they can still pursue it as a nonprofit. The second misconception, however, is that philanthropic revenue is somehow less reliable than earned income. The official statistics show that more than 50 per cent of start=up for-profit businesses fail within the first five years. Earned revenue can be highly variable. And organisations such as the United Way and the Roman Catholic Church make it clear that nonprofits can rely heavily on donations and still be sustainable. In fact, according to America’s National Philanthropic Trust, when the Standard & Poor’s 500 index fell by 45 per cent after the 2007 recession, US charitable giving dipped by only 10 per cent.
Nonprofits are “old-fashioned” and only for-profits earn respect in their sectors. While few entrepreneurs express this sentiment directly, we do hear it. Entrepreneurs are deeply influenced by the people around them. In the early years of Echoing Green, our applicants had often worked for nonprofits or gone through social-justice-oriented law schools. These days our fellows are more likely than ever to have an MBA. According to a recent survey by Ashoka U, for example, 64 per cent of universities that teach social entrepreneurship do so via their business schools rather than as part of a public policy or social work curriculum. And it seems that on a business school campus, starting a for-profit business has much more cachet than starting a nonprofit.
Three good reasons
Of course, there are good reasons to set up a for-profit too. Echoing Green first supported a for-profit in 2007 and since then we have provided $10.4 million in start-up capital to 47 for-profit companies. Here are some of the best reasons we’ve heard for using a for-profit model:
When local laws require it. Though most countries now allow some form of nonprofit corporation to exist within their borders, in several places that classification comes with such challenging restrictions (nonprofits are forbidden from protesting against the government in China, and they need a parliamentary decree to be recognised in Lebanon) that it isn’t practical. In these cases, the best way to make a major social impact may be through a for-profit.
If equity investment is the best way to access start-up capital. The rise of the impact investor is an important development in the social sector, and no social entrepreneur should leave mission-aligned money on the table. Joel Jackson (a 2011 Echoing Green fellow) launched Mobius Motors as a social-purpose car manufacturer to democratise transportation in East Africa. Philanthropic donors were not able to provide the millions of dollars necessary to support design and production, so selling equity to mission-aligned investors made good sense. The trick is not to lose sight of the fact that this will close off some philanthropic doors, and that equity investors will want to influence the business to get their money back.
To send a signal to key partners or others about the role of for-profit markets. In some cases entrepreneurs are working to improve for-profit capital markets or they’re working with for-profit entrepreneurs. David del Ser (a 2009 Echoing Green fellow) created Frogtek to provide big-company-quality business intelligence to raise the income of shopkeepers in the poorest parts of Latin America. As a for-profit, David’s organisation can rely on a higher level of trust from its customers since they know that Frogtek is facing similar challenges in the world.
The point of all this isn’t to prove that the for-profit or nonprofit model is inherently better for social impact. In fact, it’s the opposite. Our best chance to make the world better is to agree that the choice of corporate structure should be made entirely in service to social impact.
Related: Get support for your social enterprise!
Social Traders is now looking for enthusiastic and committed teams to participate in their incubator programs that includes creation of (or refinement of) a business plan, and evaluation of the most appropriate legal structure. The programs: The Crunch (for start-ups) and THRIVE (for established enterprises). These intensive programs for start-up or established enterprises provide specialist advice and facilitation to support enterprises to become financially viable and achieve social purpose through trade.
Take your next step to social enterprise success by participating in a Social Traders’ Warm-up event this September, as the first step into these programs by Social Traders.
The Author: Rich Leimsider is the vice-president of fellowship programs at Echoing Green, a global nonprofit that provides seed funding and technical assistance to emerging social entrepreneurs with ideas for social change.
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